incremental analysisFinancial decisions are often complex in nature and require business heads / managers to take a calculated approach to problem-solving. The decisions majorly revolve around the management of working capital, raising and allocating funds for various projects / expenses and managing inventory/receivables. Management decisions in turn are based on these important financial decisions that are made by using a range of analytical tools. It could be ratio analysis, studying comparative statements, trends, benchmarking or incremental analysis etc. We will be discussing the various features of Incremental Analysis, its benefits in decision-making process and also touch upon the steps involved in the actual problem-solving. If you’d like a jump start, you can try this course on Ratio Analysis and interpretation.

Incremental analysis, also called differential or marginal analysis, is the simplest approach to solving complex business decisions. It uses the ‘cost-behavior concept’ to analyze how each cost (fixed or variable) will affect the different alternatives of future income. If you are a manager or business head, facing tough decision-making situations on a regular basis, then you should first check out this course to understand the basics of business finance.

What is Incremental Analysis?

Whenever you are required to make a business decision, you have to choose from the available choices/alternatives. Incremental analysis studies the cost and revenue differences between the various alternatives to help you arrive at the decision. This problem-solving tool mainly focuses on three of the major cost components that need to be understood thoroughly for an effective analysis:

The main aspect of incremental analysis is to correctly identify the relevant costs and revenues between the various options at hand and use them to arrive at the decision. Once you have identified and separated them into variable and fixed costs, you can quickly solve the problem and make an ‘informed’ decision.

If you want to learn more on the decision-making components of Incremental Analysis, skip right ahead to our guide to finance and accounting.

Why Should You Use Incremental Analysis?

Most often managers spend a lot of their precious time in studying all the data available on the different choices, relevant or not. This leads to unnecessary wastage of productive time that they could have effectively used elsewhere. Since the non-relevant costs have no play in the final outcome of a decision, it doesn’t make business sense to examine them.

By using Incremental Analysis, managers can focus on the relevant costs to arrive at short-term business/financial decisions quickly and more effectively.

You can use this simple approach to make decisions that fall under various categories such as:

You can easily make these kinds of short-term decisions with the help of Incremental Analysis to achieve a smoother and less time-consuming decision-making process. Make sure to gather the right financial information on the various alternatives and make sure it is reliable for an error-free decision. This course on project financial modelling will show you which aspects you should focus on.

Managers across businesses normally prefer to use the Incremental Analysis technique as against the full costing method because of its various benefits. It not only saves their time but also gives accurate results that are sufficient to choose the best alternative with the information available.

Steps Involved in Incremental Analysis

Note: As stated earlier, incremental analysis uses only the relevant costs and ignores the non-relevant costs. The costs and revenues that remain same are non-relevant whereas the costs and revenues that change across alternatives are relevant and must be considered.

Based on the above mentioned steps, you can make faster, smarter and effective decisions. It’s as simple as that!

Effective use of Incremental Analysis

Incremental analysis is an effective tool to determine the best alternative that can yield the highest revenues with the least costs. Gathering the required financial information on all the options is as important as carrying out the actual analysis. The quality and reliability of the information also contribute to the success of using this tool in business decisions. Keep these few aspects in mind before you start practicing it in your business decisions. You can use this tool for solving problems across various functions of your business, be it production, sales or marketing etc. It’s also important for your financial accountants, management executives and others in the decision-making chain to understand the concepts of relevant and non-relevant costs, fixed and variable costs, net benefit and incremental analysis etc.

In short, incremental analysis is a simple but powerful analytical tool that can help you directly compare the benefits of choosing the best option. It leads to quicker, simpler and effective business decisions to maximize profits and significantly reduce the costs. For a complete course on incremental analysis, basic concepts of cost accounting and management, go right across to our course on financial accounting.

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